1. Field of the Invention
The invention relates generally to financial services, and, in particular, to management of order entry and execution in trading financial instruments for which a net asset value is periodically calculated.
2. Background Art
One of the most significant developments in trading of equity and equity-like financial instruments in the United States has been the rapid growth of trading volume in financial instruments for which a net asset value (NAV) is periodically calculated (NAV Instruments). Foremost among these NAV Instruments have been exchange traded funds (ETFs), a type of portfolio investment product first introduced in the U.S. market in 1993 that has enjoyed a high rate of growth in assets and trading volume almost since its introduction.
To illustrate the growth of trading in ETFs, 2006 trading volume was approximately 100 billion ETF shares in the United States. This volume was equal to the trading volume for all equity instruments traded on the New York Stock Exchange just ten years earlier, in 1996. In 2007, ETF volume was about 177 billion shares and, in the first quarter of 2008, average daily ETF volume exceeded one billion shares, suggesting annual ETF trading volume might exceed 250 billion shares for 2008.
As with other classes of securities, the trading volumes for NAV Instruments vary greatly from the least active to the most actively traded securities. Using early 2008 trading data, ETFs that trade more than 1 million shares per day account for about 95% of ETF trading volume. These are predominantly large funds but their trading volume is greatly disproportionate to their assets. To illustrate how disproportionate the volume is in the most actively traded ETFs, ETFs trading a million shares per day or more have assets of about $4.7 billion on average. ETFs trading less than a million shares per day have average assets of about $470 million per fund. While the assets of the most actively traded funds exceed the assets of the typical less actively traded fund by a factor of approximately 10, the average trading volume of funds trading more than a million shares per day is more than 12.5 million shares per day whereas the average trading volume of the less actively traded funds is less than 120,000 shares per day. The trading volume of the more actively traded funds exceeds the trading volume of the less actively traded funds by more than 100 times. The principal reason for the greater trading volume in the most actively traded ETFs is grounded in the history of trading financial instruments based on the indexes used for these actively traded ETFs.
The ETF was designed to provide something to trade on the floor of the Toronto Stock Exchange in Canada and the American Stock Exchange (AMEX) in the United States. History suggested to the AMEX product designers that popular indexes would be the best patterns or templates for actively traded ETF products. By the time the S&P 500 SPDR was introduced in 1993, it was well established that there was considerable interest in S&P 500 portfolio trading and in options and futures contracts on the Standard & Poor's 500. There was also substantial trading volume in other S&P and Russell index derivatives and index portfolio baskets and, eventually, in derivative products based on major Dow Jones, MSCI, Nasdaq and FTSE indexes. The introduction of additional index ETFs since 1993 and the continued emphasis on intraday ETF trading, particularly in competition and conjunction with active trading in futures and option contracts and other instruments based on benchmark indexes has lead to a continuation of the focus of active ETF trading on a relatively small number of ETFs based on popular benchmark indexes.
Today ETFs have moved far beyond the initial objective of trading an index portfolio product that led to their introduction in 1993. The mutual fund market timing and late trading scandals of 2003 and 2004 drew new attention to important characteristics of ETFs that were, in some respects, serendipitous features of their creation a decade earlier. One serendipitous feature was that, in contrast to mutual funds where investors entering and leaving the mutual fund enter and leave at net asset value with the cost of their entry and exit borne by all the shareholders in the fund, ongoing shareholders of most ETFs are protected from the costs of other investors' trading. Apart from ongoing shareholder protection from the costs of fund share trading, there are other advantages of ETFs over conventional mutual funds. Most of these advantages also appeal to long-term investors rather than to short-term traders. Probably the most important of the other ETF advantages is tax efficiency. In most ETFs, an investor need not pay taxes on capital gains until she sells the fund shares. In addition, the conflict of interest between taxable and tax exempt investors that often creates problems for mutual fund portfolio managers is resolved by the ETF structure.
In the context of investment applications, what is needed to further development of the ETF marketplace is a second trading mechanism that meets the needs of investors even if it does not generate as much trading activity as the current trading mechanism.